Legacy Wealth Weekly - Nov 4, 2016 (Bad Breadth)

Penni Johnston-gill - Nov 04, 2016

Stocks have continued their descent this week as investors became guarded about the possibility of a Trump win next Tuesday. The key highlight this week from a sectoral point of view is the breakdown in bond proxies (i.e., telecoms and utilities) as

Weekly Market Wrap-Up: Bad Breadth

Stocks have continued their descent this week as investors became guarded about the possibility of a Trump win next Tuesday. The key highlight this week from a sectoral point of view is the breakdown in bond proxies (i.e., telecoms and utilities) as investors are hedging the US election in cash rather than in bonds. Interestingly, cyclicals have held up well relative to the market, which may indicate only a temporary pause in investor risk appetite. One sector facing some challenges is energy. Oil has broken its year-to-date uptrend below the $45/bbl support level. Aside from the humongous inventory build of 14.4MMbbl seen this week, the story hurting oil prices (~10%) remains disagreements among OPEC countries which leads non-OPEC producers to stay on hold. We believe it will take more than the expected 750Kbbl production cut to reverse negative sentiment toward oil prices. This should come if crude drifts to the low $40s. Last, thanks to stronger-than-expected Chinese manufacturing data, the price of copper (+3%) has finally moved and seems on its way to breaking above the $2.30/lb resistance. More colour on our resource strategy can be found in the November edition of the QS.

Our focus this week is on Canadian equities. While we believe the S&P 500 is increasingly discounting a possible win by Trump and a Fed hike, we believe the S&P/TSX has not. Our Chart of the Week illustrates two tactical indicators we use to monitor equity corrections. The first panel shows that the spread between the S&P/TSX forward P/E (16.2x) and the CBOE VIX (~21.3) has fallen below “-5” (the “buy” zone). However, history shows that after a strong run, optimal entry points are around “-10”. Second, at corrections troughs, market breadth (i.e., the number of stocks trading above their 100-day average) usually dips at around 20%. We are currently at ~40% on the S&P/TSX compared to ~30% for the S&P 500. Therefore, going into the US election, US equities look more attractive than Canadian equities on a reward-to-risk ratio. That is, no matter what the US election outcome, US stocks have less downside risk on the way down and should enjoy a bigger oversold bounce on the upside.

Regarding economic statistics this week, in Canada, the economy created 43.9k jobs in October but this masks another decline in full-time employment (-23.1k). Meanwhile, the trade balance deficit exploded to -C$4.1B in September (from –C$2.0B), the worst print ever. Also, Finance Minister Bill Morneau updated the budget forecasts. Spending on infrastructure should increase materially and there was no hint or timeline for a balanced budget. No wonder the CDN$ fell again this week. In the US, nonfarm payrolls came in at +161k (vs. +175k exp.) but the key highlight was the increase in average hourly earnings (+2.8% YoY). Adding to the mix: another uptick in headline PCE inflation (1.2% YoY); the FOMC has now the legitimacy to proceed with a December rate hike. Otherwise, while the mfg. ISM index improved a notch (51.9, from 51.5), the service sector softened somewhat (54.8 from 57.1). In Europe, both the mfg. and service Markit PMIs posted MoM increases in October (53.5 and 52.8, from 52.6 and 52.2 respectively). Meanwhile, headline inflation advanced (to 0.5% YoY, from 0.4%) which should please the ECB. In Japan, the BoJ left rates unchanged and now sees a return to its inflation target of 2% in 2018. Finally, EMs’ economic momentum further improved, with the Chinese Caixin mfg. and the Indian Nikkei mfg. PMIs rising to 51.2 (from 50.1) and 54.4 (from 52.1).

Next week, the US election outcome should draw the spotlights. Also, we await housing statistics in Canada, retail sales in Europe and the trade balance as well as inflation in China.

The Canaccord Genuity research included in the Legacy Wealth Weekly is solely for Canadian residents. To subscribe to our weekly newsletter, click here.